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April 21, 2014

Emerging Market Uncertainty Boosts South Korea’s Appeal

In a turnabout from the height of the 1997 Asian financial crisis, many investors who shunned South Korea’s mega conglomerates, like Samsung and Hyundai, now covet them.

Investors wary of direct exposure to the emerging markets, but still seeking the benefits by the long-term upside potential that developing economies offer are particularly inclined to invest in the huge companies.

Joe Cunningham, executive vice president and head of capital markets for Mirae Asset Global Investments’ Horizon ETFs, has long been referring to South Korea as an emerged market, because “it has all the hallmarks of a developed economy,” and yet it has strong links to emerging markets.

Like Japan, South Korea – which is held in the MSCI Emerging Markets Index but doesn’t figure in the FTSE Emerging Markets Index – has a very well established manufacturing base, a strong savings rate, high income per capita growth and competitive exports, but it’s “still correlated to emerging markets growth,” Cunningham said, “so it’s a low risk way to get exposure to emerging markets, which, as we know, have not been the best place to invest in the past 18 months.”

Against an increasingly strong macroeconomic background, South Korean corporate giants like Hyundai, Samsung and LG Electronics, have gone through a significant reform process in the years since the 1997 financial crisis, and have, according to Scott Colyer, chairman and CEO of Advisors Asset Management, “come back with a vengeance” from that time and from some of the other ills that had plagued them subsequently.

“South Korean companies have done a tremendous job of supplying to Mainland China and their exports to the U.S. have also grown dramatically,” Colyer said. “Of course, these companies do face quite a bit of competition in Southeast Asia, notably from countries like Vietnam, for example, and there’s always an underlying risk in the South Korea/North Korea dynamic.

However, “these are risks we can’t really quantify, so from the standpoint that the South Korean economy is doing so well, these companies are very attractive and we think there’s nothing but upside,” Colyer said.

Of course, events outside of the business sphere like the sinking of the ferry that left nearly 300 feared dead can affect companies. Many businesses canceled social events in the wake of the tragedy.

To reflect the investment potential of South Korea, Horizon ETFs has added a product to their lineup that’s based on the KOSPI 200, a free-float-adjusted, market capitalization weighted index comprised of 200 blue chip South Korean companies listed on the KRX exchange.

The HKOR ETF offers the broadest exposure to Korean equities by number of stocks compared to other Korean ETFs, Cunningham said, and with a gross expense ratio of 0.38%, it’s also the lowest cost Korean equity ETF available to U.S. investors. The product is also designed and distributed by a firm headquartered in South Korea that has extensive market expertise.

“Any way you slice up the Korean market, you will be heavily weighted to Samsung – it’s about 22% of the index weight – and to a number of other big names like Hyundai, LG, Hynix semiconductors and so on,” Cunningham said. “But while we do have huge blue chip companies because they’re at the top of index, we also have a deep dive into other sectors that are more mid-cap names, and they may well be the next growth stories in Korea. So as a North American investor, you would want to hold these big names and also have exposure to future growth stories.”

The KOSPI 200 is the most broadly diversified Korean benchmark and it has also had a better 10-year performance than the MSCI Korea Index. More importantly, though, the KOSPI 200 has a deep options market, Cunningham said, and this is key for US investors.

“Generally when you’re investing in emerging market equities from here, you’re investing in stocks that aren’t trading a lot, so it’s a best guess of what the market value of those stocks is, and the best way to do that is through futures that trade and give you a good proxy,” Cunningham said. “The KOSPI 200 has one of the deepest futures markets in the world, with 3 million contracts traded a day, so there’s a good approximation for the value of the index. We really feel the ETF has a depth for liquidity, in addition to providing great diversification in the Korean market.”